Friday, March 19, 2010

Most people think that banks lend solely from their base of deposits. Some also know that with fractional reserve banking, they can loan out many times more than they actually have in reserves.

But very few people - with the exception of those in the banking industry and financial experts - know where credit really comes from.

Germany's central bank - the Deutsche Bundesbank (German for German Federal Bank) - has admitted in writing that banks create credit out of thin air.

As the Bundesbank states in a publication entitled "Money and Monetary Policy" (pages 88-93; translation provided by Google translate, but German speaker and economic writer Festan von Geldern confirmed the basic translation):

4.4 Creation of the banks money

Money is created by "money creation". Both [central banks] and private commercial banks can create money. In the euro monetary system [money creation] arises mainly through the granting of loans, as well as the fact that central banks or commercial banks to buy assets such as gold, foreign currencies, real estate or securities. If the central bank granted a loan from a commercial bank and crediting the amount in the account of the bank at the central bank, created “central bank money.”

***

Money creation by commercial banks

The commercial banks can create money itself, the so-called bank money. The money creation process through which commercial banks can be explained by the related postings: If a commercial bank to a customer a loan, they booked in its balance sheet as an asset against a loan receivable the client - for example, 100,000. At the same time, the bank writes down the customer's checking account, which is run on the liabilities of the bank's balance sheet, 100,000 euros good. This credit increases the deposits of customers on its current account - it creates deposit money, which increases the money supply.

In other words, money is created as book-entry by purchasing assets or entering credits on the left side of the balance-sheet and corresponding deposits on the right side. In other words, credit is created out of thin air.

Frontiers of money creation

The above description might leave the impression that the commercial banks are able to draw an infinite amount of money in bank accounts. If this were really so, this could be inflationary. The central bank therefore takes effect on the extent of lending and money creation. It requires commercial banks to hold the reserve.

As I've previously pointed out, the Federal Reserve is taking the same tack, creating conditions that guarantee that American banks will have huge excess reserves so as to prevent inflation. Back to the publication:

Central banks, commercial banks can typically obtain only by the fact that the central bank granted them credit. For these loans, commercial banks have to pay the central bank interest rate. Increase this rate, the central bank, the "prime rate", the commercial banks usually raise their part, the rates at which they lend themselves. There will be a general rise in interest rates. This, however, dampens the tendency of businesses and households, the demand for loans. By raising or lowering the key interest rate the central bank can thus influence the business sector demand for credit - and thus on Lending and bank money creation.

The commercial banks need central bank money to cover not only for the reserve, but also to the cash needs of its customers. Each bank customer may be credit in the bank account into cash to pay off. If the stocks of the banks in cash to be in short supply, the central bank can create only remedy. Because only they are permitted to bring additional notes in circulation. To meet the cash needs of its clients, the commercial bank must therefore include, where appropriate, with the central bank for a loan. This leads to the creation of central bank money. The so-purchased assets for central bank money can pay off the commercial bank in cashlet. Thus, the cash is in circulation: from the central bank to commercial banks and from these to the bank customers.

Central Bank money is also to cover the non-cash payments are required: a customer transfers money from its credit to a customer at another bank, this results in many cases led to the sending bank central bank needs to transfer money to the receiving bank. The central banks then moves from one bank to another.

***

The commercial banks can use the surplus of central bank money and to award additional credits to businesses and households. As previously described, arises from the award of additional credits additional demand for central bank money - which can be covered in this special situation of great uncertainty among banks by the existing excess liquidity. The abundant supply of liquidity relief, a bank that wants to provide a loan, from the traditional consideration of how much money they need after the award of credit is, how it is constituted, and at what cost. Using the so-called money creation multiplier can be estimated how large the potential for additional Credit limit is.

Do you get it now?

Private banks don't make loans because they have extra deposits lying around. The process is the exact opposite:

(1) Each private bank "creates" loans out of thin air by entering into binding loan commitments with borrowers (of course, corresponding liabilities are created on their books at the same time. But see below); then

(2) If the bank doesn't have the required level of reserves, it simply borrows them after the fact from the central bank (or from another bank);

(3) The central bank, in turn, creates the money which it lends to the private banks out of thin air.

It's not just Bernanke ... the central banks and their owners - the private commercial banks - have been running the printing presses for hundreds of years.

Of course, as I pointed out Tuesday, Bernanke is pushing to eliminate all reserve requirements in the U.S. If Bernanke has his way, American banks won't even have to borrow from the Fed or other banks after the fact to have reserves. Instead, they can just enter into as many loans as they want and create endless money out of thin air (within Basel I and Basel II's capital requirements - but since governments are backstopping their giant banks by overtly and covertly throwing bailout money, guarantees and various insider opportunities at them, capital requirements are somewhat meaningless).

The system is no longer based on assets (and remember that the giant banks have repeatedly become insolvent) It is based on creating new debts, and then backfilling from there.

It is - in fact - a monopoly system. Specifically, only private banks and their wholly-owned central banks can run printing presses. Governments and people do not have access to the printing presses (with some limited exceptions, like North Dakota), and thus have to pay the monopolists to run them (in the form of interest on the loans).

At the very least, the system must be changed so that it is not - by definition - perched atop a mountain of debt, and the monetary base must be maintained by an authority that is accountable to the people.

Here's a translation by Scott A:

Money Creation by Banks

Money comes into existence through "money creation". Both state central banks as well as private commercial banks are able to create money. In the Euro-system, money comes into existence primarily through the origination of loans, and additionally through the acquisition of assets by central or commercial banks, such as gold, foreign currencies, real estate or securities. When the central bank extends a loan to a commercial bank and credits the amount to the [commercial] bank's account at the central bank, then "central bank money" comes into existence. Commercial banks need this in order to fulfill their fractional reserve requirements, to satisfy the demand for cash, and for their payments transactions.

Money Creation by Commercial Banks

>> Commercial banks create money through loan originations <<

Commercial banks can also create money - so-called fiat money. The process of money creation by commercial banks can be explained by the associated bookkeeping entries: When a commercial bank extends a loan to a customer, the bank makes an entry for a credit claim against the customer on the assets side of its balance sheet, for, say, 100,000 Euros. The bank simultaneously credits 100,000 Euros to the customer's checking [OR: current] account, which is entered on the liabilities side of the bank's balance sheet. This credit entry increases the deposits in the customer's account. Money comes into existence, which increases the money supply.

Fiat money created in this manner can be used by the bank to purchase goods and to pay for services. At first glance one might think that the loan customer has become richer via this creation of money. However, this is not the case, as the customer's increased balance which was created by the borrowing is offset by an obligation in an equal amount, namely the requirement to pay back the loan. In addition, the customer must continually pay interest.

The requirement to pay interest provides a strong incentive to take out a loan only in such cases where the associated resource is actually necessary. For a business, this means that what it does with the loan has to be productive, so that it's able to realize a return which at least covers the interest expense. The origination of loans and the associated creation of money lead in this way to investments, increased production, and the creation of economic value. However, this value creation is not attributable to the money creation act itself, but rather to the productive, value-creating usage of the loan, motivated by the interest.

Loan originations and fiat money creation increase the assets and liabilities of both the borrower and the commercial bank by the exact same amounts. And the bank also does not make a profit through the act of fiat money creation considered in and of itself. But the bank does earn a commission from the loan as well as from the continual interest income. This potential for profit is offset, however, by the risk that the customer might not pay back the loan. Then the bank suffers a loss. This risk provides an incentive for the bank to exercise caution when originating loans and creating fiat money. Once created, money circulates in the economy. Either it flows from account to account, when for example payments are made via transfers. Or it is withdrawn in cash from the account and then goes from hand to hand in the form of banknotes and coins. If the loan is paid off and not replaced by a new one, then the money created by it is withdrawn from circulation. In industry jargon, this is referred to as "money destruction".

Limits to Money Creation

>> The central bank can influence the volume of loan origination and money creation <<

The above description could give the impression that commercial banks have the ability to create an infinite amount of money. If that were actually the case, then it could have an inflationary effect. For this reason, the central bank exerts some control over the volume of loan origination and money creation: it requires the commercial banks to maintain fractional reserves. To illustrate this concept, the simple example from the preceding section will be continued (in reality loan originations are a bit more complicated): if the commercial bank has increased its customer deposits by 100,000 Euros by means of the loan origination, then it must also increase its fractional reserve deposits at the central bank. Since the fractional reserve rate in the Euro-system is currently 2 percent, in this case the commercial bank needs an additional 2,000 Euros in central bank money.

Commercial banks can typically create central bank money only by having a loan extended to them from the central bank. Commercial banks must pay interest to the central bank on these loans. If the central bank increases the interest rate - the "prime rate" - then the central banks in turn generally raise the interest rates on the loans which they themselves originate. This leads to an overall increase in the level of interest rates. This, however, has a tendency to dampen the demand from businesses and households for loans. By raising or lowering the prime rate, the central bank can thereby exert an influence on the economy's demand for loans - and also on loan origination and money creation.

Commercial banks need central bank money not only for their fractional reserves, but also to cover the cash needs of their customers. Every customer can have his bank account deposit paid out in cash. If banks' cash holdings become tight, then only the central bank can take remedial action - as only it is authorized to put additional banknotes into circulation: from the central bank to the commercial banks, and from them to the bank customers.

Central bank money is additionally used for the settlement of non-cash payments transactions. If a customer transfers money from his account to a customer at another bank, this often leads to a situation where the sending bank must transfer central bank money to the receiving bank. Central bank money then moves from one bank to another.

...

Commercial banks can use their surplus central bank money to originate additional loans to businesses and households. As described above, the origination of additional loans gives rise to an additional need for central bank money - which in this special situation of great uncertainty among banks can be covered by the excess liquidity already in existence. Overabundant provision of liquidity relieves a bank from the considerations it would otherwise normally make about HOW MUCH CENTRAL BANK MONEY IT WILL NEED *AFTER* ORIGINATING LOANS, how it should be obtained, and at what cost. With the help of the so-called money creation multiplier, it's possible to estimate how big the potential for additional loan originations is. [emphasis added]

24 comments:

With all very due respect, I'm just reacting to the headline here, and perhaps to some of the fundamentals of the hypothesis.

Why is it that the fact that credit is created out of thin air all that earthshaking?

Consider a community store in the early 1700s in the US. Assume no bank. A person who grows tomatoes comes in, and wants to buy a loaf of bread a week before the harvest. The retailer says sure, I know you are good for it.

"Why is it that the fact that credit is created out of thin air all that earthshaking?"

It is obvious to a savvy financial expert such as you (100% sincerely). But it is the exact opposite of what most Americans believe. They believe that excess reserves - coming from deposits into the bank - are the basis for loans.

I added the following preface to this essay when I posted it to a financial site read by savvy financial experts:

"While this concept might be obvious to the financial experts who read [this site], it is a startling revelation for most people."

"While this concept might be obvious to the financial experts who read [this site], it is a startling revelation for most people."

This all seems -an- innocuous enough estimation of perceptions here there and everywhere else...

The delusion concerning common mistaken perceptions about competence in these matters would come more clearly into view -however-, were any one of the many fine financial experts here -or anywhere- give the milling crowd of economic-blind-men an estimation concerning the proportional relationship between size of the real economy of goods and services -and- the size of the extended credit-innovation-economy that so tenuously supports our modern economic-idiocy most seem so utterly incompetent in comprehending.

In other words, the world can easily suffer the guy with the tomato crop being wiped out by an unusually heavy hail storm in a single afternoon. (The shopkeeper is left a little short.)

BUT -this is not our case today in the credit economy built-up so incredibly disproportionate to the real economy.

Computers are absolutely necessary for this teetering debacle.

And Clever Ben's innovation to remove all necessary reserve requirements, might seem like a good idea for a while, and even to some boing-boing Austrian economists here...

But not to anyone who is capable of assessing the overall trend in these matters.

Wylie E. Coyote is funny in part because he seems forever to get dropped from ever higher heights. He also seems funny because the bombs given to him also seem to grow exponentially larger.

The humor though -is less convincing with these endless credit bombs being dropped on our modernly bloated populations so utterly dependent upon everything working smoothly.

People are dying, kids.

World War III seems to have already begun, or so the relatives of the one million war dead in and around Mesopotamia would have us believe, -could we hear their cries of anguish and despair from here -on this board.

You can thank the credit economy for all of it beginning with those first tentative steps by the first lenders and the first borrowers.

Pull out your mirror, Monkey-face.

Humans are primates, and primates are thieves, -YES THIEVES.

And humans are warlike too. Humans are even more warlike than other primates.

We make both economic depressions -and- war with computers now -thanks to the cult of genius surrounding every new innovation.

All our recent history's quick fixes are toppling over like dominoes now.

Stimulus was economic and social poison.

And now -none of these many geniuses has a permanent solution or even a quick fix for what is coming our way next.

What I find so amazing is, some of these people still think there's like-maybe a rabbit in the hat?

It's sort of like, we all know Bernanke and Geithner are faking it, total-bungling-frauds -without a clue, -but- maybe they got lucky, right?

The rabbit hole gets deeper, however. As each loan is made, interest is charged out of 'real' money. That interest is not created out of whole cloth, and goes into the bank's central assets. Eventually, the 'real' money all goes to the bank, followed by real property. As time wears on, all money, and all property belongs to the bank in the fiat system.

At which point you either work for the bank, or the bankers, or you receive what they choose to give you.

The banks own your homes, your transportation, control your goods and services you create, determine which businesses grow and fail, and then invest in the 'stock market', to make a profit from that growth or failure.

They are uniquely positioned to create panics, and boom times, to fail a bank, sell short their options, and still profit, because they are the ones that determine the future, by setting the rate of interest, who receives loans.. or strategically denying them.

And all poised with the ultimate of insider knowledge, unlimited fiat money creating unlimited debt, and then making it near impossible to live without that credit.

If you want to see the cause of consumerism, look no farther than the banks and credit.

In essence banks don't have to create money out of thin air. They should grant a loan against pledged goods or hard assets (which can't be created as fast as the printing-press is able to run). In this way they bring into circulation not the present value of some goods and services as they ever did, but the present value of land and capital-goods which is rising through the emission of the newly printed money. Thus inflation is the very business of banks and central banks.

Bill, if two people trade tomatoes for bread, there are actual assets being exchanged.

In the banking system, there are no assets being exchanged (ok, maybe 1/10th what the borrower thinks being exchanged is exchanged), because the banks, due to fractional reserve lending, actually only have AT THE MOST 1/10th of what most people would think they have.

The real number is more like 1/100th because banks redeposit fractional reserve loans that borrowers get from other banks.

Woops. I misread that. I thought there was an actual trade going on in your example.

Part of the problem is that people have to accept bank debt as legal tender. It wasn't always like that. A bank is a private institution whose ability to repay varies from bank to bank. But because of government fiat, there can be no rejection of a bank's notes due to its credit-worthiness. If a bank issues debt, it must be accepted into the general economy as "good as gold," so to speak.

So, in the tomato/bread example, let's say the tomato guy writes the bread guy an IOU for 50 tomatoes. That's all well and good. But then if the bread guy tries to pay let's a say a third person who sells fish with that IOU. The fish guy doesn't have to accept it, because the fish guy might not think that the tomato guy is good for it. That is precisely the option that we don't have with bank credit.

@g, that translation. when an elucidation is patently incomprehensible it should be revealing (ie a tip off of a rip off). as s. connery said ... " if that is a confession my ass is a banjo." ? the fine line between genius and psychopathy?it is sad that the truly sick among us are frequently slightlymore intelligent than most of us!the fed has crossed over into the realm of thesociopath, as have others in that sphere.note: fascists do not recognize themselvesas such in the mirror. and .. they cannot.it is prohibited, an ego thing. a being "good"thing, a belonging to the group, popularity,being adjusted and intelligent thing. a conforming thing..they think very big, which is good, but havenot maintained a perspective concerning thehuman. the small, the individual, the source. replaced the source with a symbol and a narrative of ambiguous but powerful import.humanity sacrificed in theprocess of identification with the process, thegaming of the process. they have taken up the prospect of actually implementing the new worldreligion based on credit creation and set themselves up as the gods. the fiat gods of digital credit. they have the weapons and faithful warriors to enforce adherence to their arbitrary and fiat law. they reserve the right to create or destroy credit or law at will. . this power they claim is within their grasp,as it is within the grasp of the individual also. it is the essence of man, humanity, to create his world as he sees fit, extend himself or his credit as he believes, speculates, thinks, wishes, dreams, needs etc.. . it's nature and natural. but......there are real consequences for everyone andeverything. effects. causes manifest. and thechain going backward in time and forward in thought to comprehension, an intellectual process resulting in consciousness. of ( ).. rule one, broken. when you extend credit andit fails, you lose out. you don't get to extendsomeone Else's credit. but if you do and this also fails you don't get to then repeat the thing at exponential powers. and when that fails you don'tget to remain as authority of credit and then do it again. this time with no reserves. ? are we really having this discussion? . so they are proposing a faith based, public is prepared?, system of no reserve credit extension. as religion has preached to the true believers and "good" followers as the proper attitude and posture before god. and that is the thermite that willdestroy the pillars, has destroyed, of the individual. the constitution, law, government,the family, community, etc...all to be slaves / dependent for the power tostand on their own two feet on someone Else's earth under someone Else's sky with total allegiance to the flag of the bank.. it is the source of destruction also, destruction being by design, required, atthis stage of construction. a naked power grabwith opportunity for further grabs as "god" sees fit.. all that is required is that men do nothing..

Excellent post and reactions...don't have a lot to add, maybe some bitting humor will do. Why are central bankers like the plant of the apes? Because the gorillas have all the weapons, nets, horses and ride around all day shooting the people.

I'd like to know who was the ass hole who first let a private bank to come in and take the power away from the government to coin money? The idea of private individuals being able to creat money out of nother is crazy as well as dangerous as we all can see now!

It was highly insolvent kings, princes and other scumb@gs, who first went into the deal with goldsmiths and bankers to have them lend private money in promise to repay more. All this backed with the taxing of the unsuspecting lowly subjects.We were basicly sold in debt slavery centuries ago. Remember that, when you see suits hanging from lampp0sts in this summer.

In reading all the comments the book writen by William Bramley "The Gods of Eden" came to mind.In it he explains how banks started and how they created money fron the very beginning. Most important is WHO.

"Why is it that the fact that credit is created out of thin air all that earthshaking?"

Because if you create money out of thin air and then lend it you end up owning everything having paid nothing, offered nothing and done nothing except bludgeon off other people's lives, dreams and efforts. It's a scam.

Government enables central banks. Read "The Creature From Jekyll Island" for how it started in the US. Without fiat legal tender, politicians would have to raise taxes, which is political suicide. Instead they sell the money franchise to banksters. Our current monetary system is a Ponzi scheme. Inflation is simply embezzlement. Owning precious metals is "going off the grid." Read "Freedom's Vision" at SwarmUSA.com for a workable plan to take back the money power given to us by the Constitution.

This is actually documented quite well by Paul Grignon in his animated "Money As Debt" animated video. What is even more frightening is that Bernanke is pushing for even less "leverage" in the fractional reserve methodology -- that is, instead of a 1-to-nine ratio, a complete absence a ratio altogether.

By creating money AS debt, the banks eventually own EVERYTHING in the country, because they charge interest on loans, which is never totally repayable, as it is impossible to produce sufficient goods to meet the interest, seeing as the money 'earned' by the banks on interest was summoned out of thin air...

"The modern banking system manufactures money out of nothing. The process is perhaps the most astounding piece of sleight of hand that was ever invented. Banking was conceived in iniquity and was born in sin ... The﻿ Bankers own the earth ... if you wish to remain the slaves of Bankers and pay the cost of your own slavery, let them continue to create money and control credit." - Sir Josiah Stamp, Director, Bank of England (the UK's Central Bank), in the 1920s

We are grateful to the Washington Post, the New York Times, Time Magazine and other great publications whose directors have attended our meetings and respected their promises of discretion for almost forty years." "It would have been impossible for us to develop our plan for the world if we had been subjected to the lights of publicity during those years. But, the world is more sophisticated and prepared to march towards a world government. The supranational sovereignty of an intellectual elite and world bankers is surely preferable to the national autodetermination practiced in past centuries."

Web of Debt and Money as Debt are both severely flawed. The Creature from Jeckyl Isle is a much better read for the average person. Ellen Brown is a noneconomist and a clown for writing containing such glaring inaccuracies.

The Interest paradox is not a real phenomenon; I'll simplify it a bit: banks pay their employees, those dollars can be reused and recycled again and again on interest. The real paradox is that they make interest on money that was created from thin air. Money is uncreated when the loan is payed. No government can be trusted to print money PERIOD. The solution is NOT to put the sole control of monetary creation in the hands of our government. Our government DOES control money creation-- and it chooses to put it into private hands. It would pursue the same course of action (funding welfare/warfare state) REGARDLESS.Private competing currencies are the best (admittedly imperfect) solution to this problem. Go read some Friedrich Von Hayek. Fractional reserve banking is immoral because of the 100 percent guarantee that depositors are given is an illusion and because the banks make interest on money they didn't have to earn (USURY). The monetary expansion it creates causes distortions in relative prices LEADING TO BUSINESS CYCLES. The idea that we can spend our way into prosperity (as advocated by Brown, Tarpley, Money Masters etc) is advocated only by noneconomist monetary CRANKS. The shortage of money idea is a another red herring (unless you count the plummeting of the monetary base when banks go under; THIS DOESNT HAPPEN IN MODERN TIMES: WE HAVE THE FDIC AND BAILOUTS.) Its discredited Keynesianism with another name. GO READ SOME AUSTRIAN ECONOMICS and learn about sound money and what drives the business cycle!

Bill: If the store fronts you Bread, they had to work for that bread. Its a real asset. Banks could do this to, with depositing representing actual wealth. This would be obvious to real financial expert (Ive been studying economics in college for less than a year).

I think what this boils down to is why should the public have to pay copious amounts of interest, fees, and other miscellaneous charges on cash loans that the bank has conjured up out of thin air Do they have the moral right to get grossly wealthy by charging interest on money that never existed in the first place while at the same time putting the public further into perpetual debt? I would think not. Why any government would grant a private business the right to issue it's currency that it creates from nothing and then loan it out with high interest attached is beyond me It's obvious that this sort of setup is prime territory for corruption

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